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The mainland needs to establish a deposit insurance system as it liberalises its interest rate regime, Bank of Shanghai chairman Fan Yifan said yesterday.

The remarks by Fan, who is also a vice-president of the country's sovereign wealth fund China Investment Corp followed talks by the central bank in June that it was establishing a system to protect depositors amid mounting concern about mainland lenders' deteriorating asset quality.

"For the sake of protecting the interests of depositors, it is a must to create a deposit insurance system," Fan told a banking forum in Shanghai yesterday.

He became the first top boss of a mainland bank to publicly push ahead with the establishment of such a system.

Song Xiangyan, a deputy director with the international department at the People's Bank of China, said in June that China would create the system when the timing was right.

Under a deposit insurance system, commercial banks are required to deposit a portion of the funds into a deposit insurance institution, covering a bank's insolvency risks.

It is widely believed that mainland banks are exposed to a huge risk of bad loan problems after they granted credits to support the country's infrastructure-focused stimulus package in 2010 to 2011.

The China Banking Association, a government-controlled consortium of banks, estimated that 70 per cent of the more than 10 trillion yuan of loans extended to the local governments in line with the stimulus package were unlikely to be fully repaid. Beijing has a tight grip on interest rates with banks enjoying a high net interest margin while raking in handsome interest income.

Most mainland residents had believed that it was safe to put their savings in banking deposits because the banks, most of which are owned by the state, would never collapse.

Beijing began taking initial steps in creating a market-based mechanism to set interest rates earlier this year, and the move is likely to intensify competition among lenders.

The reform would narrow the spread between the deposit and lending rates, increasing chances of bank failures as some might not be able to generate enough profit to offset bad-loan risks.